Securities Regulation Daily PCAOB adopts enhanced auditor’s report, proposes revisions to auditing estimates and use of specialists
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Thursday, June 1, 2017

PCAOB adopts enhanced auditor’s report, proposes revisions to auditing estimates and use of specialists

By Jacquelyn Lumb

The PCAOB has unanimously adopted a new auditor reporting model, the culmination of six years of outreach and public comment, which requires auditors to address critical audit matters (CAMs) that arose during the audit of an issuer’s financial statements. Chair James Doty said the Board’s action will breathe new life into the current formulaic reporting model which has not changed in more than 70 years. The new report also brings the U.S. in line with what has become the norm around the world with enhanced auditor disclosure.

Critical audit matters. The auditor’s report will retain the current pass/fail opinion but will add disclosure relating to accounts or matters that are material to the financial statements and matters that involved challenging, subjective, or complex auditor judgments. The auditor’s report must include the identification of each CAM, a description of the considerations that led the auditor to determine that the matter was a CAM, a description of how the CAM was addressed, and a reference to the relevant financial statement accounts or disclosures.

Auditor tenure. In addition, the final standard requires the disclosure of the year in which the auditor began serving consecutively as the company’s auditor, a statement that the auditor is required to be independent, and a number of changes in the report’s presentation. For example, the report will describe the auditor’s responsibility to obtain reasonable assurance that the financial statements are free from material misstatements. The opinion will move to the first section of the auditor’s report and the report will be addressed to shareholders and the board of directors or equivalents.

Exemption for EGCs. The communication about CAMS does not apply to audits of brokers and dealers; investment companies other than business development companies; employee stock purchase, savings, and similar plans; and emerging growth companies (EGCs). The staff explained that the final standard does not apply the CAM requirement to EGCs due to questions about whether, under the JOBS Act, it is legally permissible to mandate the disclosure for EGCs.

Effective dates. If approved by the SEC, all of the provisions of the final standard, other than those related to CAMs, will take effect for audits for fiscal years ending on or after December 15, 2017. The CAM provisions will take effect for audits for fiscal years ending on or after June 30, 2019 for large accelerated filers, and on December 15, 2020 for all other companies to which the requirements apply. Auditors may voluntarily comply with the standard once it is approved by the SEC.

Board member Steven Harris, while approving the adoption of the standard, said it falls short of what the standard might have been by allowing auditors to determine the areas that posed the greatest challenge. This subjective requirement will be difficult to enforce for compliance, in his view. The standard also stops short of mandating a discussion of what the auditor found when it addressed a CAM, the disclosure of which was supported by the Board’s Investor Advisory Group. Harris also expressed regret that the Board exempted EGCs from the CAM requirement given that these companies may pose a greater risk to investors.

Jeanette Franzel was skeptical about the requirement to disclose the duration of the auditor’s tenure. While the release disclaims any relationship between the auditor’s tenure and either audit quality or independence, she is concerned that including the information in the auditor’s report may suggest such a relationship. She urged academics to study this area to help determine the impact and usefulness of the auditor tenure disclosure once it is implemented.

Proposal on auditing estimates. The Board also unanimously approved two proposals relating to accounting estimates and the use of specialists. The proposal for auditing accounting estimates, including fair value measurements, emphasizes the importance of applying professional skepticism and paying more attention to potential management bias. If adopted, the proposal will replace three existing standards with a single standard. It is intended to focus auditors on the estimates that pose the greatest risk of material misstatement. The proposal includes specific requirements for addressing fair values of financial instruments, including the use of information from pricing sources.

Proposal regarding specialists. The proposal relating to the auditor’s use of the work of specialists aligns with the Board’s risk assessment standards. It strengthens the requirements for evaluating the work of a company’s specialist and applies a risk-based approach to supervising and evaluating the work of both auditor-employed and auditor-engaged specialists.

Chief Auditor Martin Baumann noted that accounting estimates are pervasive for large and small companies. Given that significant judgment is involved, he said it may increase the risk of material misstatements. Auditing estimates have proven challenging for auditors, based on inspection results, he added. The proposals will establish a uniform risk-based approach to testing and evaluating specialists’ work.

The comment period for both proposals will be open through August 30, 2017.

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